Price protection is a common business practice intended to counteract the effects of high technological obsolescence. For example, in high-technology industries where the risk of technological obsolescence is high, price protection has become a standard element of contracts between manufacturers (OEMs) and distributors or retailers. Distributors perceive price protection as a fair and necessary mechanism through which manufacturers (OEMs) decrease the effects of brutal price erosion on operations of distributors. To exercise a price protection contract, an OEM evaluates its distributors' purchases over the price protection period at the time of a price change, and compares the purchase quantity to the distributor's current inventory holdings. Whichever is smaller is the price protected quantity. The OEM issues the distributor a credit equal to the product of that quantity and the price decrease.
The following illustrates a simple example of how price protection works. A computer distributor places an order for 100 server computers at $800 per unit. There is a price protection contract with the original equipment manufacturer (OEM), with the price protection period being 4 weeks. At the end of 3 weeks, the distributor is left with 30 units after a demand of 70 units is satisfied. At this point, the OEM reduces the wholesale price to $700 per unit, reducing the value of the distributor's inventory by $100 per unit. The price protected quantity is the unsold inventory of 30 units as it is lower than the 100 units ordered within the last 4 weeks. The price protection credit given to the distributor is the product of the unsold inventory and the price decrease, or $3,000 dollars in this example.
Previous studies on price protection contracts have considered only a single-period setting using parallels to buy-back contracts. Those studies do not address price protection in a natural multi-period setting. In addition, while known methodologies have addressed optimizing inventory stocking levels at a distributor location, those methodologies do not consider the effects of price protection on the stocking decision. Accordingly, it would be desirable to have a method and system that capture time-dynamics of price protection programs in inventory stocking or replenishment.